When people think about the different types of investors in stock market, they often think about “active vs passive investors”. Or “retail vs institutional investors”. Much has already been written about all of these types of investors, so we thought we’d take a different perspective.
3 Types of Investors in the Stock Market
In this article, we highlight the 3 types of investors in the stock market based on their approach to investing and investment analysis:
- Fundamental Investors
- Data-driven Investors, and
- Technical Analysts
Why just these three?
As a new investor, it can be a daunting task to figure out which investments you want in your portfolio.
There are thousands of publicly traded companies listed on exchanges around the world. Naturally, picking only a few to invest in is no small feat.
To get started, it may help to understand the categories of investors as it relates solely to stocks and investment analysis so that you can focus your learning.
By picking an ethos that resonates with you, it will drive progress more efficiently toward becoming better at analysing stocks and managing your investments.
What are the “traditional” types of investors?
If you still want to learn about the traditional type of investors, however, here’s a quick overview.
Active vs Passive Investors
Active investors actively manage their investment portfolios. They believe, and will attempt to, earn returns that are greater than the market portfolio.
Put differently, the active investor will:
- constantly iterate and improve their investment strategy
- actively rebalance their portfolio to ensure optimal portfolio weights
- influence and execute their own asset allocation decisions
Passive investors on the other hand, don’t actively manage their investment portfolios.
Passive investing largely involves investing in an index fund that tracks the overall stock market. Some might choose to invest in mutual funds, too.
And by doing so, they can somewhat be “active” whilst still being a passive investor.
For instance, they might invest in an actively managed mutual fund, but not delve in any asset allocation decision making themselves.
Retail vs Institutional Investors
Investors can also be categorised or grouped by their “profession”, or access to capital.
Generally speaking, retail investors tend to be the “average joe”, or the “common (wo)man” investing in the stock market.
Institutional investors on the other hand, include “informed investors” who are part of an intuition.
Institutions can include (but aren’t limited to):
- Hedge funds
- Mutual funds
- Investment Banks
- Venture Capital firms/funds
- Private Equity firms/funds
Okay, now that you know what the “traditional” types of investors in stock market are, let’s examine the three types of investors based on their investing ethos.
And then we’ll help guide you to pick which one is the best fit for you.
You’ve probably heard of this type before simply by being involved in the investing journey.
A fundamental investor is one who chooses a particular investment based on:
- careful analysis of the financial statements, and
- trends of a company’s performance.
Some might think of fundamental investors as making decisions based on news, but that’s not always the case.
Certainly, news can have an impact on a fundamental investor’s decisions. But that only comes after attaining a firm grasp on:
- where a company gets its revenues from, and
- what might have a big impact on a company’s bottom-line profits.
For instance, the success of oil and gas companies is closely related to the price of crude oil for obvious reasons.
As the commodity rises in price, so too does the profit potential that oil and gas companies can expect on the same output of product.
Fundamental investors will understand not only what the company is doing from a management standpoint but also what the price of oil is doing and why.
They will also have a firm understanding of a company’s financial statements including its:
- Income Statement (aka P&L Statement),
- Balance Sheet (aka Statement of Financial Position),
- Cash Flow Statement (aka Statement of Cash flows),
- Statement of Changes in Equity, and
- Notes to Financial Statements
These financial statements are required to be filed at certain intervals, typically at least once a year.
And they paint a picture of the financial health of the company.
Depending on the timeframe over which an investor hopes to profit (i.e., short term or long term), the financial statements may be critical to the decision-making process for fundamental investors.
Utilising data to make investment decisions isn’t exactly new.
After all, data is defined as “facts and statistics collected together for reference of analysis.” (per the Oxford English Dictionary).
Investors have been using simple stock price movements since the beginnings of stock markets to make investment decisions.
However, data, at least as we know it today, has turned into a much bigger monster for investors today.
The sheer amount of data is truly mind boggling. So the only way for any meaningful analysis of data to be conducted is by using computers to conduct analysis on hundreds, thousands, or even millions of data points.
With all of this data available to even the average investor, this is where opportunities like quantitative investing are presented.
Data-driven Investing Strategies
Using some of the newer data-driven investment strategies, there are methods to implement both active and passive trading strategies that use data analysis to comb through the massive amounts of information quickly and present findings within minutes rather than days.
As the speed of the world increases, investment decisions require such quick calculations.
Don’t confuse data-driven investing with technical analysis, however.
While there are certainly those who swear by the efficacy of technical analysis, it is and will always be one of the most subjective types of investing.
Factor investing is a method which utilises different factors like:
- interest rate
- momentum, etc.,
And it uses these factors to identify areas of the market which might benefit from the current market trends.
Quantitative investing, as you might imagine, involves using complex maths and statistical calculations to quickly find opportunities and execute trades.
While these are slightly complicated and require some learning, there are far more approachable than you might imagine.
With a bit of learning, even investors with a small account can utilise some of these data-driven strategies to achieve above-average excess returns.
Investors who use data points and graphical indicators like charts, trendiness, etc are often considered technical analysts or technical traders.
This category often includes not only technical analysis traders but also algorithmic and high-frequency traders.
Importantly, while fundamental and data-driven investors use objective facts to make investment decisions…
Technical analysis tends to be quite a bit more subjective as we’ve already discussed.
Technical analysis traders will typically be looking at price charts in various forms and use technical indicators to paint a picture of what price action has been doing in the past.
In theory, this information points to what price action may do in the near term. This assumption of potential future price movement is how technical analysts choose their positions.
This type of investing is perhaps one of the most convoluted to learn simply because it tends to be more of an art than a real science.
And the weak form of the Efficient Market Hypothesis (EMH) clearly shows that this sort of trading is largely useless.
You can understand all of the tools and concepts that technical analysts use to make decisions. But the strategies that make one technical trader successful can be copied to a letter by another, and the two might realise completely different results.
That makes it one of the least successful types of investing.
Because of the subjectivity surrounding technical analysis, it is generally not recommended as an effective investment tactic nor strategy.
There are far better ways to invest, and you will more than likely spend more money and time than you can possibly make up by trying to learn an effective technical analysis strategy.
Which Type of Investor Are You?
Obviously, the first two types of investors are going to be the easiest to learn.
That’s because they come with objective concepts and have generally been used successfully for:
- generations in the case of fundamental investing, and
- decades for data-driven investing.
To figure out your investment style, the first step is to understand your risk tolerance.
Ask yourself how you might react to sudden and severe downturns in the market. Fundamental analysis tends to be more in tune with those who want to buy and asset and hold it for some time.
Warren Buffett would be an excellent example of a successful fundamental investor.
While data-driven investing has risks like any other strategy, approaches like backtesting or statistically validating strategies can help greatly reduce these risks.
Also, you can certainly find effective long-term data-driven strategies, so don’t let the hype of high-frequency trading push you toward thinking it’s solely a short-term method.
In either case, the actual investment decision is important. But managing the position after you’ve entered a position is just as important.
What’s Next: 3 Types of Investors in Stock Market
There are many things to consider when deciding which type of investor you are.
The stock markets of the world offer prospective investors thousands of opportunities to invest every day.
Some of them are good, but to know which ones, you need to focus on choosing a category of investing and hone that skill.
Just as there are thousands of companies to invest in, there are just as many investing strategies. By closing in on a specific style, you can filter out much of the noise in the investing world.
As you can imagine, reducing the noise in the finance world can help focus on what matters, and spending time learning finance and investing strategies to advance your investment goals.